As we approach the summer months, many global markets have taken a slight downturn following the cautious optimism of April. Much of the volatility is still being driven by rising energy costs, inflation, and speculation around interest rates.
The US market (particularly the technology sector) has fared better in May despite the backdrop of negotiations around the debt ceiling. While AI is the latest theme to emerge from the tech sector, we should not forget about cryptocurrency – proposals are in place to increase regulation in this area, which could bring crypto into the mainstream.
What is the Debt Ceiling and Why Does it Matter?
Discussions around the debt ceiling have dominated the US financial press this month, as Joe Biden aims to strike a deal to raise the cap on government borrowing.
Like many governments, the US spends more than it makes in tax revenue, and needs to borrow to cover the deficit. They do this by issuing government bonds, or ‘Treasury Bills’ (similar to UK gilts) for investors to buy. Once the debt ceiling is reached, no more bonds can be issued and an essential supply of money is cut off.
The debt ceiling is currently over $31 trillion, and has been increased 78 times since 1960. With approximately $30 trillion of debt currently outstanding, the government is rapidly approaching its cap. If the debt ceiling is not raised, the US risks defaulting on payments. Given that the US represents over half of the world’s economy by market share, this could be devastating for the economy, the currency, and the global market.
Of course, increasing debt comes with its own issues, and the government must also consider wider fiscal matters, such as taxation and spending, to arrive at a compromise.
Discussions have taken place throughout May, with a conclusion likely in early June.
Are Bonds Worth Buying?
After a catastrophic 2022 in the fixed interest market, bond sales have started to pick up again. With inflation and interest rates rising, and equity markets uncertain, investors are seeking options for stable growth.
However, this has not been enough to pick up the bond market as a whole, with losses still building up throughout May. Index-linked gilt funds have suffered the most, dipping by a further 8% this month following even heavier losses in 2022. Investors would need to have held index-linked gilts for 10 years to have seen any kind of positive return in the current market. High yield bonds have fared better, with modest losses of 0.1%. Corporate bonds and standard gilts fall somewhere between the two.
Bonds still have a place in an investment portfolio, as in normal market conditions they provide stability and diversification against equities. Of course, sometimes the performance can be unpredictable, with wide discrepancies between the different types of bond, depending on when they were issued, the yield, the credit rating of the borrower, and the term to maturity. The key is to hold a diverse range of bonds, and to keep the equity to bond ratio in your portfolio consistent with your chosen level of risk. Switching between bonds and equities as markets fluctuate is unlikely to yield the best results.
Following an unpredictable few years in the crypto market, new proposals are underway to bring greater regulation to the industry.
The government’s view is that crypto should be regulated in the same way as any other financial service. This means bringing in rules around who can issue digital currency, what it can be used for, and ringfencing customers’ money to keep it separate from the company’s assets.
Critics suggest that crypto should be treated more like gambling, given that the assets have no intrinsic value and investors could lose all of their money. The theory is that by treating crypto as an investment, this could cause investors to feel more secure and underestimate the risks.
Discussions are ongoing, but there has been an important development in tax reporting for digital currency. From 2024/2025, investors will be required to complete a standalone section to declare gains from crypto assets. This is intended to increase tax compliance.
The UK Market
The UK market has experienced a slight dip this month. The UK All Companies sector is down 2% on the month, with the FTSE 100 dropping by 4%. This follows a fairly optimistic April, with retail sales and consumer spending exceeding expectations. However, high energy costs (as well as a reduction in government support) are taking a toll on businesses and consumers.
The top performing companies this month are diverse, including Citivas Social Housing, cruising company Carnival, and TI Fluid Systems.
The worst performers during May included ASOS plc and engineering company Wood Group.
There is no clear pattern to the performance, with highs and lows seen across all sectors.
The Global Outlook
The US market picked up mid-month, with total returns of over 2% in the North American sector. While the debt ceiling discussions have been at the forefront of the financial press, the growth has mainly been driven by the tech sector. Over 20% of companies in the S&P 500 not only achieved positive earnings results in the first quarter of the year, but also cited AI as a key reason for this. While this may turn out to be another ‘tech bubble,’ there is no denying that AI is changing the way businesses work.
The Asia Pacific sector has been relatively stable, with a small increase of 0.4%. Chinese manufacturing has slowed for the second consecutive month and exports have also started to decline as the rest of the world copes with the cost of living crisis.
The European market has dipped by 1.2% in May. There are multiple factors behind this, but this is most likely due to the Ukraine war and energy crisis which continue to have an impact.
Please don’t hesitate to contact a member of the team for more information on any of the topics covered.
The value of investments can fall as well as rise and is not guaranteed. Past performance is not a guide to future performance.
The content in this article was correct on 31/05/2023.
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